ICRA Lanka to grade IPOs

Friday, 29 July 2011 02:54 -     - {{hitsCtrl.values.hits}}

CEO W.D. Baranabas of ICRA Lanka – an associate of Moody’s Investors services – says credit rating provides a basis for determining the returns compared to the risks involved or perceived and that it is a very useful benchmark for issue pricing and results in saving in costs. Following are excerpts of an interview:

By Cathrine Weerakkody

Q: To begin, has ICRA Lanka Limited started operations?

A: Technically we are in operation. Our license was granted in end May. Now we have recruited a core team. Once the team is on board, they would be sent to India for training. In the interim we would be supported with seconded staff from the parent company. Hence even now I am in a position to undertake a rating assignment. ICRA Lanka is a fully-owned subsidiary of ICRA Limited of India, an associate company of Moody’s Investors service. The company was incorporated in December 2010 and was granted license by the SEC in May 2011 as Rating Agency.

Q: What about your parent company ICRA Limited?

A: The parent company was set up in 1991 by leading financial/investment institutions, commercial banks and financial services companies as an independent and professional investment information and credit rating agency. Today, ICRA and its subsidiaries together form the ICRA Group of Companies (Group ICRA). ICRA is a public limited company, with its shares listed on the Bombay Stock Exchange and the National Stock Exchange.

The international Credit Rating Agency Moody’s Investors Service is ICRA’s largest shareholder. The participation of Moody’s is supported by a Technical Services Agreement, which entails Moody’s providing certain high-value technical services to ICRA. Specifically, the agreement is aimed at benefiting ICRA’s in-house research capabilities, and providing it with access to Moody’s global research base. The agreement also envisages Moody’s conducting regular training and business seminars for ICRA analysts on various subjects to help them better understand and manage concepts and issues relating to the development of the capital markets. Besides this formal training programme, the agreement provides for Moody’s advising ICRA on rating-products strategy and the ratings business in general.

Q: There are two rating agencies established in the country. Do you think there is a place for a third?

A: It all depends on how one looks at the market. If one takes the view that our financial market needs to be developed significantly, if we want to achieve the true potential of our country and economy and also the objective of the Government to make the country the next miracle of Asia, then there is significant scope and opportunity for the rating industry. We do take that view and are here for the long term. Given the current status of the financial market, there is a challenge. We are willing to take up that challenge.

Q: When you talk of the development of the financial market, what are you envisaging?

A: The financial market in a nutshell is the one which mobilises resources and allocates them to productive investments. The efficiency level of this process is the indication of the level of development. If one looks at our financial market, we are still at a very basic level. Even the largest of our corporates depend on bank financing for their debt financing. The debt market is almost nonexistent. In most developed, economies, the debt market is very large. The pricing would be risk-based. We would need to move towards that so that there would be efficiency in the market.

Q: How would you as the third rating agency differentiate your agency from the other two?

A: ICRA Lanka’s information products, ratings and solutions would reflect independent, professional and impartial opinions, which should assist businesses enhance the quality of their decisions and help issuers access a broader investor base. We strongly believe that the quality of analytical output is a reflection organisation’s research capabilities. Towards this end, we will have the required in-house capabilities, to maintain the highest standards of quality and credibility.

The focus and commitment of ICRA Lanka in the coming years will be on developing innovative concepts and products in the market environment, generating and promoting wider investor awareness and interest, enhancing efficiency and transparency in the financial market, and providing a healthier environment for market participants and regulators in Sri Lanka.

Q: What are the services you intend providing in Sri Lanka?

A: ICRA Lanka would provide a range of rating services. Issuer or entity rating service is a key product. ICRA Lanka’s issuer ratings would provide an opinion on the general creditworthiness of the rated entities in relation to their senior unsecured obligations. ICRA Lanka will also rate rupee denominated debt instruments issued by commercial banks, non-banking finance companies, financial institutions, manufacturing and service companies, among others. ICRA Lanka also rates structured obligations and sector-specific debt obligations. The other services offered include stakeholder value and governance rating, credit risk rating of debt mutual funds, rating of claims paying ability of insurance companies, project finance rating and line of credit rating.

We also provide grading services which employ pioneering concepts and methodologies. These include grading of Initial Public Offers (IPOs), Microfinance Institutions (MFIs), construction entities, real estate developers and projects. In IPO grading, an ICRA Lanka-assigned IPO grade represents a relative assessment of the ‘fundamentals’ of the issue graded in relation to the universe of other listed equity securities on the Colombo Stock Exchange.

In MFI grading, the focus of ICRA Lanka’s grading exercise is on evaluating the candidate institution’s business and financial risks. The grading of construction entities seeks to provide an independent opinion on the quality of performance of the entities graded. Similarly, the grading of real estate developers and projects seeks to make property buyers aware of the risks associated with real estate projects, and with the developers’ ability to deliver in accordance with the terms agreed.

Q: Why is credit rating so important and how does a rating help an investor?

A: Credit rating is a simple and easy to understand symbolic indicator of the opinion of a credit rating agency about the risk involved in a borrowing programme of an issuer with reference to the capability of the issuer to repay the debt as per terms of the issue. This is neither a general-purpose evaluation of the company nor a recommendation to buy, hold or sell a debt instrument. The credit ratings provide an investor with critical information to enable him to take an informed investment decision based on his risk-return preferences. These also help investors to select the appropriate investment opportunities from a large range of options available

Q: How are credit ratings done?

A: ICRA Lanka ratings are based on an in-depth study of the industry as also an evaluation of the strengths and weaknesses of the company. The inherent protective factors, marketing strategies, competitive edge, level of technological development, operational efficiency, competence and effectiveness of management, hedging of risks, cash flow, trends and potential, liquidity, financial flexibility, Government policies, past record of debt servicing, sensitivity to possible changes in business/economic circumstances are looked into.

Q: How long does a Rrating remain valid?

A: Once the company has accepted a rating, ICRA Lanka continuously monitors the corporate and the rating is monitored till the life of the instrument. The process is known as surveillance. During the surveillance period, all changes affecting the company are taken into account and the rating, if necessary, is changed, upwards or downwards. In other words, a rating is valid during the life of the instrument unless is changed. If the rating is that of an entity, it will be valid till the issuer withdraws after giving due notice.

Q: How reliable are your ratings?

A: ICRA Lanka maintains absolute independence from market participants to provide unbiased opinions. The ratings are a result of collective judgment of rating committee. ICRA Lanka’s in-house research and database ensure that opinions are supported by objective benchmarks and per comparison. Credit ratings are not recommendations to buy or sell or hold a specified rated security nor are they offered as guarantees or protections against default. They are opinions only. Specific credit rating opinions are not intended to measure many of the other factors that fixed – income investors must consider in relation to risk – such as liquidity risk, pre-payment risk, interest rate risk, risk of secondary market loss, or exchange loss risk.

Q: Who are the beneficiaries of the rating services and how would they benefit?

A: For the investors, credit rating is an information regarding the relative ranking of the default loss probability for a given fixed income investment in comparison with other rated instruments. The rating provides the investors with an independent and professional judgment of the credit quality of the instrument, which the individual investor would not otherwise be able to evaluate. Rating provides low cost supplement to the in-house appraisal system of organised institutional investors. The rating replaces name recognition by objective opinion.

The issuers of rated securities are expected to have an access to a wider investor base. This stems from the fact that more and more investors are using rating as a tool for decision-making and there is faith placed by the market on opinions of rating agencies. Credit rating provides a basis for determining the returns compared to the risks involved or perceived. This could be a useful benchmark for issue pricing and result in savings in costs. Intermediaries like investment and merchant bankers and other market players use the rating for pricing, in placement and marketing the issues. The ratings are used in case of asset securitisation and structured obligation. The rating makes the exposure levels and risk undertaking decisions easy.

Q: As a final question; are there mandatory rating requirements?

A: In many countries, the world over, the regulators have set certain benchmarks and rules for various market intermediaries or financial intuitions, etc., based on the rating for investment, exposure and dealings. In Sri Lanka too, there exist mandatory rating requirements. Banks and financial institutions are required to be rated. Implementation of Basel 2 has brought about mandatory ratings of borrowers as well. In Sri Lanka, this is not made mandatory yet. In countries like in India, borrowings above certain value have to be rated mandatorily.

(The writer is an undergraduate student at the University of Warwick, UK.)